2011 Issue 1 - Bright Future Non Profit Financing

A Bright Future For Non-Profit Financing?

The past three years have witnessed dramatic developments in the

capital markets resulting in a fundamentally changed, still evolving, and,

in many respects, significantly improved financing climate. Both access

to capital and the breadth of financing alternatives have expanded

while interest rates have remained low and relatively stable. The causes

of this more hospitable environment are several, and the benefits to

non-profit borrowers are many:

Structurally simpler and sounder “bank bought” transactions are

eclipsing the traditional variable rate demand bond (VRDB)

structure.

Long the province of large investment-grade-rated banks, the

non-profit market is witnessing the emergence of well

capitalized regional and community banks as competitive

sources of financing. The increasing number of banks active in

the non-profit sector is creating greater competition in the

lending community resulting in lower capital cost for non-profit

borrowers.

In response to the growing reluctance of borrowers to use

interest rate swaps, traditional “variable rate” lenders are now

offering “true fixed rate” options for periods up to 10 years and

amortizations of up to 30 years.

How did all of this happen and what does it mean for non-profits

pursuing financings or refinancings?

Inside This Issue

2 The Rise and Fall of VRDBs

2 BQ Bonds… First to the

Rescue, Then off to the

Sunset

3 And Now… The “NBQ”

Bond!

3 To What End a Public

Offering?

5 The Blessings of

Competition and Price

Transparency

Wye River Group is an

independent financial

advisory firm focused on

the financing and

investment needs of non-

profit organizations.

SERIES 2011 | ISSUE 1

JUNE 2011

Non-Profit Finance:

Fresh Perspectives

NON-PROFIT FINANCE | FRESH PERSPECTIVES

The Rise and Fall of VRDBs

VRDBs have long been the most popular tax-exempt financing vehicle

for non-profit organizations. Over the past 10 and 20 years, VRDB

borrowers have enjoyed average borrowing costs of 1.80% and 2.60%

respectively (excluding the cost of remarketing services and the letter of

credit (LC)). Since the early 2000s, borrowers have been sold on the

idea of fixing “synthetically” their variable rate borrowing cost by

purchasing an interest rate swap. The vulnerabilities of financing

structures involving VRDBs and companion swaps were fully exposed

during the credit crisis of 2008-09:

LC bank credit rating downgrades resulted in increased VRDB

rates and in some instances, the collapse of the market for such

bonds.

Borrowers discovered the meaning of “basis risk” as their interest

rate swaps failed to hedge increases in VRDB interest cost.

Mark-to-market losses on swaps, often combined with significant

erosion in investment portfolio values and radically increased

debt service cost, triggered financial covenant violations with

an array of negative consequences.

BQ Bonds… First to the Rescue, Then offto the Sunset

Many non-profit borrowers struggling with “broken” VRDB financings

found salvation in a refinancing with “Bank Qualified” (BQ) Bonds.

Under the stimulus-motivated American Recovery and Reinvestment Act

of 2009, the new, but temporary, BQ exemption for non-profits was not

only a timely solution for the restructuring of troubled bond issues, but a

radically new financing alternative that challenged banks to offer less

expensive and structurally simpler direct loans with features non-profit

borrowers wanted most:

a variable rate option with an interest rate that is indexed rather

than market driven,

no “basis risk” for those inclined to synthetically fix their variable

rate financings, and

better yet, for borrowers desiring predictable borrowing cost

without a hedge, “true fixed rate” options.

“The vulnerabilities of

financing structures

involving VRDBs and

companion swaps were

fully exposed during the

credit crisis of 2008-09.”

Bank Qualified Bonds


Between 2009 and 2010, it is estimated that approximately $70 billion

of non-profit BQ financings were completed. During the same period,

new issuance of VRDBs declined by nearly half, with a significant

amount of outstanding VRDBs redeemed or refunded with BQ Bonds.

Unfortunately, the tenure for the special BQ exemption was brief. It

expired on December 31, 2010. Legislation has been introduced to

reauthorize the exemption, but the prognosis for its passage is dim. But

even if the special BQ exemption never returns, it has had a profoundly

beneficial impact on the non-profit community, with banks continuing

today to offer “BQ-like” financing alternatives.

And Now… The “NBQ” Bond!

“Non Bank Qualified” (NBQ) financing is rapidly achieving prominence

as the successor to BQ financing. Here is what we are seeing in the

most recent (2011) financing solicitations conducted for our non-profit

clients:

Despite the loss of the BQ exemption, a significant number of

banks are still offering “bank purchased” alternatives to LC-

backed VRDBs.

Banks are not only offering both variable and true fixed rate

options, but pricing is reasonably in line with last year’s BQ

levels. Typical variable rate options are being priced at 67 to

77% of LIBOR plus a “spread” and true fixed rates for good

credits have ranged from 2.50% for a 3-year term to up to

4.00% for a 10-year term.

For variable rate financings, banks are offering swaps whose

pricing is calibrated to the related bond rate index to assure

effective hedging.

To What End a Public Offering?

In light of the expanded financing repertoire of banks, that is a good

question. For most non-profit borrowers, it is hard to justify a public

offering of fixed rate bonds unless the borrower is either:

an “AA” or better rated credit with a relatively large borrowing

requirement ($30 million plus) and a strong desire to secure a

fixed rate for the full term of the debt, or

“For most non-profit

borrowers, it is hard to

justify a public offering of

fixed rate bonds…”

0

20,000

40,000

60,000

80,000

100,000

120,000

2006 2007 2008 2009 2010

VRDB vs. BQ Issuance($ in millions)

VRDBs BQ Bonds

Source: The Bond BuyerFigures are based on issuesmaturing in 13 months or longer


at the other end of the credit spectrum, a non-rated credit with

a financing requirement that cannot satisfy the lending criteria

of banks (for instance a high “loan to value” need or a

significant dependency on future growth in revenues to support

debt service).

In general, the disadvantages of a public offering relative to a bank-

based financing are significant:

transaction costs that can be twice as high or more,

the interest rate is not fixed until all financing documents are

completed and the bonds are sold, which can take months

from the start of the transaction, exposing the borrower to

potentially higher than planned rates,

there is usually a debt service reserve fund requirement equal to

10% of the borrowing amount, exacerbated by a significantly

negative carrying cost under current market conditions,

the initial and ongoing annual public disclosure requirements

can be burdensome,

there is an early repayment limitation, usually in the form of a 10-

year redemption prohibition, and

the interest cost will be 150 to 250 basis points higher than that

of a 10-year, bank-purchased alternative under current market

conditions.

Moreover, as a practical matter, relatively few long-term, fixed rate

bond issues ever even run full term. Interest cost saving opportunities,

new borrowing requirements and other changes in circumstances

inevitably prompt the refinancing or early repayment of a significant

number of such issues. Consequently, if a non-profit can borrow under

current market conditions at an all-in fixed cost of 4.00% for 10 years, it

may be hard-pressed to justify the public offering alternative at

appreciably higher interest rates.

ABC Non-Profit

Fixed Rate Financing Options

Year NBQ Public Offering

1 --- 1.95%

5 --- 3.80%

7 --- ---

10 4.25% 5.35%

15 --- 6.00%

20 --- 6.20%

30 --- 6.50%

All-In Cost 4.37% 6.55%

Source: The Bond BuyerWRG Managed Transactions

Key Assumptions: BBB Credit Quality $10 Million Borrowing; 30 Year Term NBQ Callable in Year 10


The Blessings of Competition andPrice Transparency

Today, borrowers have the opportunity to reap the benefits of (1)

increasing competition among a growing number of capital sources

and (2) mechanisms that can harness competition to their maximum

advantage. In our experience, competitive solicitations directed to all

logical financing candidates consistently produce better pricing and

terms than one-on-one negotiation or “price shopping”. At our firm,

we have developed web-based solutions to streamline solicitation,

information dissemination and proposal analysis. The result is a highly

compressed and cost-effective process that enables a broad based

market solicitation of 25 or more financial institutions, the selection of a

preferred lender, negotiation of a commitment letter and transaction

documents within 90 to 120 days. This compares to the more

cumbersome and expensive process for VRDBs or public offerings that

can typically span 180 to 270 days.

For non-profit borrowers, debt financings will almost always be “mission

critical” and great care should be taken to assure that the financing

serves the mission. Non-profits owe it to themselves and their

stakeholders to secure financings on the most economical and cost-

efficient basis with reasonably contained transaction costs. Bank-

based financing offers non-profits those opportunities. The challenge

facing each non-profit borrower in these transactions will be

managing the planning, solicitation, evaluation and implementation

phases of the financing process to the best economic advantage.

The assistance of a knowledgeable and motivated independent

financial advisor can help assure that result.

For More Information:

Wye River GroupIndependent Financial Advisors

522 Chesapeake Avenue | Annapolis, MD 21403 | www.wyeriver.net

“In our experience,

competitive solicitations

consistently produce

better pricing and terms

than one-on-one

negotiation or “price

shopping”.”

2011 Issue 1 - Bright Future Non Profit Financing

Economy & Finance

Transcript of 2011 Issue 1 - Bright Future Non Profit Financing